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A Deckers Short Squeeze

Spend enough time short-selling and you will get pretty good at
spotting short squeeze candidates. The problem with this is that
when you are short, it can often be very challenging to switch
sides because you have usually adopted quite a negative view of the
company in question. But if you can detach yourself from this view,
there is good money to be made leveraging your knowledge in a stock
you have been shorting playing a violent squeeze rally.

In fact, if you exclude options activity, a great short squeeze
almost always offers a better percentage return opportunity than
patiently shorting a stock. Right now, I am sniffing out such an
opportunity emerging in Deckers (
DECK
) shares.

Decked by Deckers

I'll admit, as a short-seller, I have not had many good
experiences with Deckers. Now, you might be wondering how that is
possible considering the decline in the stock over the past year,
but it is true. Most traders/investors when it comes to shorting
will tell you about their great successes, but in my case the
trades that remain freshest in my memory are the total failures.
And when it comes to those experiences, I can recall every last
detail.

See, you usually don't learn much when something works right
away, but when you are shorting a strong stock and it is not
working, you tend to learn a lot because the position turns into a
test of endurance. It's like running in a market marathon, your
success hinges more on your mental fortitude than your bank roll.
Was I too early? What's the difference between too early just
meaning I was wrong, and too early meaning early but right? When
does stubbornness become stupidity? And when does performance
frustration overcome sound analysis and conviction? If you have a
good deal of short-selling experience, you probably have asked
yourself these questions.

I first shorted Deckers in 2007 thinking the Uggs brand was a
total fad. It was a relatively medium sized position as most of my
short selling attention was being focused on Crox (
CROX
), but I still liked it a lot. After about a 30% loss in a month
and a half, I covered. I really didn't have a good reason for
exiting other than the fact that I was getting even more crushed on
my CROX short and saw more reward in that position. Basically, I
had to cut and take a loss on something and Deckers was it. I then
pretty much shelved the name for the next four years.

When I finally came back to it in 2011, the stock was almost
double where it had been when I first shorted it in 2007. But this
time around my thesis was a bit different than a simple fashion fad
blowup. I was focused on rising input costs, namely sheepskin
prices, and battering margins. I opened what I felt was a decent
sized initial short position at $65 and watched the stock climb 30%
within a few weeks. Nobody seemed to care about rising raw material
costs, and I really didn't have much more to go on than that. So,
after a small dip, I covered again with a loss. But I hate giving
up on a thesis I feel is right despite a lack of overwhelming
evidence, so I came back a month later.

This time my timing was lucky and the stock fell 15% almost
immediately after I initiated my position. Of course that didn't
last long, within a month the stock reversed and was on its way to
a new all-time high. This was despite increasing evidence that raw
material costs were becoming a more serious problem. So, instead of
shorting more at the peak I sat tight and when the shares got back
to my cost basis I covered. I figured, as many others before often
have, that I'd wait for a bounce and just buy some six month OTM
puts on the name to limit the takeover risk that seemed to be
emerging in the space.

Problem is that bounce never came, and the stock has been in a
free fall ever since. And this is a mild short-seller failure story
because I never was too excited about the idea. The market cap
wasn't big enough to sufficiently mitigate brand acquirer risk, the
fad argument was flimsy, the valuation never that extreme, and the
management seemed very competent. Compare that to a name like
[[FSLR]] which I shorted many times in its bubble days on what I
felt was a bullet proof thesis, and missing out on Deckers doesn't
sting nearly as much. But I still hate to watch a stock I was once
shorting collapse without me in it, so I try and stay on top of the
story looking for an edge to exploit at some point.

Squeezing your Edge Out

Learning about a company, industry, and what's driving a stock
on a quarterly basis requires a significant time investment. And
there is an opportunity cost issue when you are shorting because
you are often choosing between certain companies or industries and
trying to hit a narrow window. Not capitalizing on one is usually
compounded by also missing out on another stock you had a strong
view on. Hence the desire to flip the trade and use your knowledge
to make money in the other direction.

A good short squeeze like Netflix (
NFLX
), Nokia (
NOK
), FSLR, Green Mountain Coffee (
GMCR
) have gone through at times over the past year can move the stock
of a company with major fundamental issues 50%-100% in weeks. As a
former short seller of all the aforementioned names, I have gotten
pretty decent at spotting these moves and, when supremely
comfortable, participating somewhat.

Here is what I look for:

1) A series of disappointing quarters culminating in a kitchen
sink quarter from management that ultimately ends up having little
permanent impact on the share price. Recent examples include First
Solar and Green Mountain Coffee.

2) Favorable seasonality. This works well for retail stocks as
longer-term issues can get overshadowed by temporarily favorable
seasonal dynamics.

3) Played out short arguments, i.e., declining margins,
oversupply, rising inventories etc. Once these become obvious to
everyone or show the slightest hint of reversing, the stock becomes
a coiled spring.

Presently, Deckers is exhibiting all three of these traits.

Kitchen Sink Quarter With a Muted Stock Reaction

Over the past two years, we have raised prices on selective
key styles to help mitigate the impact of an 80% increase in our
sheepskin and raw material costs over this same period," stated
Angel Martinez, President, Chief Executive Officer and Chair of
the Board of Directors. "We believe that these selective price
increases, particularly during a period of one of the warmest
years on record, has pushed us above the consumer's price-value
expectations for the UGG brand. We also believe that this has
resulted in softer than expected third quarter sell-through
trends in our Company owned stores, and has pushed back the start
of the brand's key selling season at retail this year. However,
based on positive consumer feedback, the performance of new
product introductions, and market research data, we continue to
be confident in the strength and popularity of our brand
portfolio and the multiple growth opportunities that still lie
ahead.

When I read this paragraph the minute their earnings were
released I knew that the cycle of quarterly disappointments had
come to an end. No matter what Deckers reports next quarter,
management has finally set expectations at a level low enough to
build off of going forward. From a stock perspective that is
critical if you are looking to flip sides or even just play a
temporary and violent squeeze. And though the shares fell almost
20% on this news, the real story here was that in a mere six days
almost all those losses were reversed. That tells you there was a
good deal of short covering and no pile on momentum shorting.

Favorable Seasonality

Uggs boots are predominately a winter season purchase, and thus
as we approach the holiday season the calendar flips in their
favor. Add in that this past year was one of the warmest on record
in North America and you get the nice added benefit of pent up
demand to go with the seasonality.

Played Out Short Arguments

Deckers' big problem over the last 18 months has been a near 70%
rise in sheepskin prices eating into margins and subsequently
causing some pricing missteps that impacted demand. Both of these
issues are reversing course with sheepskin prices slated to fall
and management readjusting pricing on key Uggs downward to preserve
long-term brand equity. Also, the inventory issue which I track
religiously when I am shorting a stock like this seems to have
peaked this past quarter and should return to more normalized
levels.

Put all these factors together and you have a very solid case
for being long the stock from now until their next earnings in
January. And if you have studied past moves like this, your
expectations should be for a 50% or greater increase of the bottom
simply on short covering and shifting sentiment. Non-news driven
moves like these are usually the most lucrative, so when I spot
them I tend to get excited about the opportunity, and in Deckers'
case, I am even more excited than usual because I think the Uggs
brand is actually fundamentally healthy.

This makes things more interesting because going long doesn't
just entail playing short covering, a temporary shift in sentiment,
and bombed out expectations. At these prices you can argue that the
stock is actually fundamentally attractive on a valuation basis and
maybe even a great fashion brand acquisition candidate. That makes
not watching the daily tape a lot easier, and the need to manage
the position a lot less important.

Disclosure:
I am long [[DECK]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.

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